Wednesday, June 14, 2006

The Pits

When I’m stuck in traffic anywhere in the vicinity of New York, I call Mike.

Mike is the busiest real estate lawyer I’ve ever known. He handles five to six closings a day in the New York Metropolitan area—and he basically spends 250 days a year in his car, driving from Queens to Staten Island to Rye to Brooklyn and back to Queens, handling deals.

After doing this for twenty years, Mike—to put it mildly—knows his way around The City. So, when I was stuck in traffic on the way to Yankee Stadium last night, I called Mike.

And in the course of getting from Mike the best way to get to the House That Ruth Built before the first pitch was thrown (“Where are you? Okay, listen, here’s what you do…”), I also got the low-down on Mike’s real estate business—which mainly involves multi-family, middle-to-low income homes:

“It’s the pits,” he said cheerfully. “Thank God I socked it away the last couple years.” He asked, “You remember 5, 6 years ago? Before 9/11?” I said I did. “It’s like that. I’m down to one or two closings a day.”

It seemed like only yesterday—but it was actually just last summer—that the home-builders and the real estate-happy day-traders-turned-condo-flippers had decided rising interest rates wouldn’t stop the housing boom, thanks to all the factors that people point to when they’re buying into a bubble, but which can be summed up in one sentence: “It’s different this time.”But it isn’t. “It’s the pits.”

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

16 comments:

The real question here is what happens to consumer spending after the giant infusion of home equity dries up, coupled with the real estate brokers/home flippers/mortgage bankers/etc. that are going to see their incomes get sliced?

A lot of people around my age (mid-late 20's) have jobs in this arena and tend to be one of the demographics that spends almost all their income. One person I know, who worked for a mortgage company, said that the mortgage activity was slowing down 6 months ago - she is now unemployed.

Since the savings rate has gone from the 7 percent range 15 years ago to negative today.. this can't be good for consumer spending, which hasn't been weak in a long, long time.

Blogs are now becoming my favorite and first choice in getting the real life news in real time. Besides this one, I've followed Housing Panic by a guy named "Keith". He's been the best at following housing in real time, the growing listings, the sinking prices, the situations developing in different markets and calling the bs put out in the mainstream media by real estate pros verses actual happenings. Mainstream media is useless to me. Its always way behind the curve.

It seemed like only yesterday—but it was actually just last summer—that the home-builders and the real estate-happy day-traders-turned-condo-flippers had decided rising interest rates wouldn’t stop the housing boom, thanks to all the factors that people point to when they’re buying into a bubble, but which can be summed up in one sentence: “It’s different this time.”

We will know if it's different on the other side of the downturn. If the consolidation of the builders will have helped on the supply side such that the market is not flooded with spec inventory and prices hold up, then it will have been different. The national new home market so far this year has deliveries down 22% with orders down a like amount. Larger builders have taken share, so their deliveries aren't down as much. Prices, meanwhile, are up a median of 8.9% YTD annualized across 52 MSAs from a survey I use (link below). According to Freddie Mac data, prices were up 12.7% YoY in Q1 nationally.

Volumes are down because prices are up. Psychology is also poor, consumer sentiment isn't great, and yes, many speculators have cleared out. But is this the pits? I don't think so. 500K new home sales with prices down 3% nominally on a national basis would be the pits.

I know you don't argue stock price, either, but what's the point otherwise? I believe the pits scenario is in these stocks by a large factor and can live with a 20-30% YoY drawdown in stock price on the original purchase, especially if a company is extracting captial and buying back its stock at 5x EPS, at a 30% FCF yield, and at 120% of book.

It's difficult to be a contrarian; by definition one must constantly fight popular opinion such as that written here. As Keynes said: "Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally."

I guess if being a contrarian was easy, it would be impossible to make money.

By the way, exactly what does Mike charge for closings? I went to independant attorneys when I was buying a house and all of them wanted the same fees as a realtor would get; about 4-6K. If Mike is closing "only" two a day, he's raking in about 10 k a day! Poor guy! Yeah, I sure hope he's banked some rainy day money.

Thinking about your post led me to pose some questions about future consumer spending:

A) If home owners (some, not all, of course) are using home equity loans to "clean up their balance sheets" (i.e., pay off credit card debts, auto loans, etc.), will the income that once went toward loan repayments be saved more or spent more?

B) With the number of home owners taking out home equity loans to pay off debts, will this mean that home owners stay in their homes longer to pay off their HE loans on top of their existing mortgage?

C) What percentage of gross domestic product (GDP) does the income from real estate brokers, mortgage bankers and home builders/construction companies comprise? Is there any sector of the economy that can "pick up the slack" from a potential falloff in income from real estate operations (hello, industrials)?

I wouldn't worry so much about the Gen Y demographic and their spending habits. I would be more concerned about the saving habits of the Baby Boomer generation and how their savings will translate into future consumer spending once they retire.

Jeff, Mike is your indicator guy mine is the forclosed property disposal guy. During the boom, my guy, was taking on average 2-3 properties a day, now a typical day he is processing over 10+ per day. Our feeling up here outside Boston and I know on the face this seems outlandish but we wouldn't be shocked by a rollback of upto 40 points in value.

Our feeling up here outside Boston and I know on the face this seems outlandish but we wouldn't be shocked by a rollback of upto 40 points in value.

I wouldn't bet on it. There is twice as much inventory in the Cleveland market as there is in metro Boston. Not twice as much per person and not twice as much per square mile, but 14,505 MLS entries vs. 7,579 for Boston. Boston is also flattish from the peak on prices.

Definately all good questions.. about A+B, I see your point, I guess it's a question of how much of this "borrowing" is going to pay down other debt vs. being outright spent. I have no idea what it is - my anecdotal experience has been the latter, but it certainly is a tiny sample.

About C, I certainly don't know the answer, and this might be flawed logic, but something like 25-35% of consumer spending (via the CPI calculations) is on housing, and consumer spending is 2/3rds of all domestic spending.. I don't want to guess a number here, but I'd have to think whatever it is is significant.

Another point I forgot to mention originally is about all of the variable rate mortgages that are due to adjust over the next 2 years. That certainly has to be a negative as well.

I certainly hope the economy can absorb some of the slack.. I just don't know in what sector.. do we really have any "weak" cyclical sectors right now?

About C, I certainly don't know the answer, and this might be flawed logic, but something like 25-35% of consumer spending (via the CPI calculations) is on housing, and consumer spending is 2/3rds of all domestic spending.. I don't want to guess a number here, but I'd have to think whatever it is is significant.

According to the BEA, 31.7% of personal consumption expenditures go to housing, with 7% going to mortgage interest and charges and 3.3% going to mortgage principal (the latter is not a PCE item, but it's a cash item). Greenspan and Kennedy sized mortage equity withdrawal at $650B or so last year and hypothesized half of that goes to consumption, so that's $325B on a consumer economy of around $8T, or about 4% of unusual stimulus from elevated home price appreciation. If you assume there's normal churn of $250B or so in mortgage equity withdrawal, about $400B would be unusually stimulated with $200B going to consumption -- resulting in stimulus of about 2.5%.

Regarding cyclical sectors needing workers- It has been quite hard to get long-distance truckers and roughnecks to work on oil rigs. Both jobs are competing with the homebuilders. The choice for the worker is whether they want to be home every night, or to be on the road, or work in the elements in remote places. Building has been the preferred work, but that may change now.